The boom in technology-related stocks has left funds investing in mid-250 companies with a choice be...
The boom in technology-related stocks has left funds investing in mid-250 companies with a choice between capital growth and yield.
Managers favour shares in the FTSE 250 index because the dividend yield on the index is 4.26% which outstrips the yield offered by the FTSE 350, at 3.21%.
So far this year the mid-cap index is up 29% due to increased interest in internet and software companies. Conversely, many stocks offering relatively high yields, such as engineering companies, have suffered due to the lack of exposure they have to technology. While the share prices of high yielding stocks continue to fall, software and internet stocks are rising.
Income managers have had to decide whether to sell the stocks due to the decline in capital value or hold on to the stock because of the yield it offers. Gartmore's solution to the problem is to strike a balance between the requirement of a steady stream of income and some capital growth.
Tim Gregory, manager of Gartmore UK Growth & Income unit trust, agrees that some of the stocks have been brilliant performers while others have been adversely affected by the technology squeeze.
He says: "There is generally a two-tier market. There are the ones which are performing well but do not offer much of a income. For instance Gartmore has exposure to Bowthorpe, a technology systems testing company, which only offers a yield of 1.5%. But since I first bought into the company three years ago at £3.50 the share price has grown to £9.22."
Chris White, fund manager at Johnson Fry, says UK equity income fund managers face a challenge. They have to have capital growth, dividend growth and a dividend yield 10% above the FTSE All-Share Index.
He says: "In the current frenzy for technology and telecommunications stocks it is important to have exposure to the growth companies in growth sectors and barbell the portfolio by investing in higher yielding stocks in areas which are less exciting."
General industrial group Berisford is one of the stocks Gregory favours in the FTSE 250 that is underperforming when compared to technology.
Gregory says: "We look for companies with earnings surprise. Berisford is buying up US catering companies and has a good cashflow and good management but has performed less well in this environment. On the upside it offers a yield of 3.5% which is well above the All-Share average, and its dividend growth is double digit."
The Gartmore income fund is 20% weighted in bonds, 12% in resources companies such as BP and Shell and has some exposure to high-yielding cyclicals allowing Gregory to invest in growth stocks.
Johnson Fry UK Income is neutral in large growth companies, such as Vodafone and Marconi which have negligible yields. As the earnings come through, dividend from these groups is expected to follow.
White says: "This solves the first two problems which leaves the question of where to get the yield on the portfolio. High yielding convertibles such as Williams and Liberty International account for 20% of the fund. These provide a high level of income but also have the prospect of capital growth if we see recovery in the underlying equity. Williams is currently trading near its bond floor so the downside is very limited whilst the conversion premium is quite low at 22%. The fund also selects certain high yielding equities, which it feels have the prospect for capital appreciation. Bass and GUS both provide yields over 5% and now look completely oversold in the rush for technology stocks. Bass results last week suggested that there are no fundamental problems with any of the group's businesses whilst GUS should bought as a cheap way into Experian, the credit business, rather than its home shopping division whose problems are more than reflected in the current price."
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